Wednesday, October 31, 2007

How To Win the Election in 2008 (Fed Meeting Special)

Very little is certain in life, but we can say with absolute certainty that both the Republicans and Democrats want to win the November 2008 elections. We can also say with assurance that there will be winners and losers. Let's consider the scenarios which would lead to victory for each party.

Elections come down to one thing: the voters' pocketbooks. If the economy is doing fine and voters are employed and feeling wealthier, side-issues occupy center stage. But when the economy is tanking and voters are losing their jobs and feeling poorer with each passing day, then gay marriage and all the other "culture wars" issues which have served the Republicans so well over the past seven years will be quickly relegated to the same dusty bin as Nehru jackets and East Germany.

So what conditions are necessary for each party to win? What does each party have to engineer to insure a Nov. 2008 win?

1. the Republicans need the rotten-to-the-core, faltering economy to hold together until November 2008. The Democrats need it to tank by summer '08.

If gasoline prices and inflation have shot up--as they most certainly will as the Paulson/Bernanke Team destroys the U.S. dollar with endless rate cuts--then the Republicans will lose just as surely as the sun rises in the morning.

The Repubs can hope their current manipulation of data/bailing-wire-and-duct-tape act will work another year, but even the most loyal Elephant must be harboring some doubts that the "more of the same" lies about low inflation and the stupendous health of the credit markets can survive a year-long encounter with reality. If the Republicans gut the dollar, inflation will gut the economy and their chances of winning any election.

Here's what the Republican leaders should do if they have any hope that the economy will support their chances next year.

They should sit Hank Paulson (Treasury) and Ben Bernanke (the Federal Reserve) down and say, "Hank and Ben, you guys have done great jobs pulling the wool over the public's eyes about how fragile our economy really is, but we all know your dog-and-pony show can't last another year. If you send the dollar to sleep with the fishes, then oil will skyrocket and inflation will eat us alive."

Ben and Hank will shift nervously in their seats, because they thought they'd done exactly what their political masters had ordered: slather the B.S. on so thick that a few credulous nincompoops might actually believe them. "So Hank and Ben, don't cut the Fed rate. Yes, the stock market will take a hit, but better now than a year from now. For now, we have to do a Reagan and talk about the sacrifices which must be made to strengthen the dollar and kill inflation. You know, whatever Reagan said that worked."

"If we let the market tank now, then maybe by next summer it will be recovering, and we can declare victory over inflation. So you see, Ben and Hank, we really have no choice. If you keep killing the dollar, inflation will take away our chances of winning. Because you know what election banner everyone in the country will be watching? The price of gasoline at their local gas station. If it's high because you let the dollar fall in half and oil goes to $120 a barrel, voters will see $4 per gallon everywhere--and we are doomed."

2. Meanwhile, over at the Democratic High Council, the victory plan is considerably different. There the brilliant strategists are engineering the exact opposite future: one in which the economy plummets so hard by October that angry voters of every stripe will swallow whatever reservations they might have and vote Democratic.

Here's the linchpin of the Democratic plan: hammer the Republicans on their abject failure to protect consumers. Where were the regulators when the mortgage industry careened off into a risk-be-darned orgy? Where were they when investment bankers created exotic financial instruments and then arbitrarily set the values via "mark to model"? The Repubs have no defense; they are extremnely vulnerable because they did in fact completely fail to protect consumers. Their interests were one-sided: help enrich their wealthy pals on Wall Street.

But here's the truly brilliant part of the Democratic strategy: enact legislation that requires every financial instrument to be marked to market at the close of every trading day. That would be any financial instrument--stock, bond, mortgage-backed security, CDO, derivative, SIV, everything owned or traded by any firm based in or trading in the U.S.--virtually everything.

The moment this measure became law, a full financial meltdown would ensue. Amidst the carnage, the Democrats would hammer on the excesses, the lack of oversight, and the unceasing support of rich Wall Streeters which characterized all eight years of the Republican reign. There would be little for the Republicans to defend, for the meltdown itself would constitute proof that they'd abetted a fatal lack of responsible oversight.

Maybe the Fed will foolishly drive the stake deeper into the heart of the flailing dollar today with another rate cut. But maybe not. If they decline to prostitute the Federal Reserve to the capricious greed of Wall Street, we would do well to wonder if there is a deeper, far smarter strategy being played out "For the Money Next November."

The New York Stock Exchange said it will no longer impose curbs on computer-program trading that were put in place after the crash of 1987, claiming they're no longer as effective in damping swings in prices.

The exchange will stop prohibiting brokerages from entering some program trades when the NYSE Composite Index rises or falls more than 2 percent, according to a notice sent to member firms today. The so-called collars had been in effect since 1988 and were triggered 17 times this year, according to a filing with the Securities and Exchange Commission.

Roger added these cogent comments:

Why would they do this after the experience of 1987? Or am I missing something? I don't like it one bit but I am not a trader and do not know how things work in the trading pits.

Are we being set up for a fall? If so, there are some 'short' ETF's out there that may fit the bill as I do not trade options.

And for your viewing pleasure, here is a chart of the VIX/volatility index. Is this the chart of a VIX which is set to decline as the market races up in Fed-rate-cut euphoria? Absolutely not. It's the chart of a VIX about to rise as the market falls.

As I write this Tuesday morning, both gold and oil have fallen from their recent peaks. Hmm. If the Fed is about to decimate the dollar with a big cut, why are gold and oil falling?

Let's say you and your pals knew the Fed would "disappoint the market" by not cutting rates, or not cutting enough to goose the market ever higher. What would you do?

1. You'd sell gold and oil which have risen on the expectation of the Fed giving Wall Street a big gooey load of rate-cut candy.

2. You'd go short with put options and short-selling into the rate-expectation rise.

3. You'd engineer the end of the trading curbs which might have limited the market's fall. Now it can fall more than 2%, hugely enriching you and your pals in a matter of hours or days. Recall that as the market plummets, short positions and puts rise in value.

Or am I making all this up? You be the judge. The VIX and the pulling of curbs that have been deployed 17 times this year alone certainly looks peculiar to me, but maybe it's nothing. Maybe the Fed will serve up a juicy half-point rate cut and the market will spasm reliably higher on the fabulous news that the U.S.A. has officially abandoned its currency to the junkyard dogs. Happy day. Or maybe not.

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